L3 - elasticity

• Elasticity refers to the responsiveness of a variable, such as quantity or price, to a change in another variable, such as income or the price of a related good
• Elastic


  When a change in one variable results in a relatively larger change in another variable, the relationship between the two variables is elastic. The coefficient of elasticity is greater than 1
• Inelastic


  When a change in one variable results in a relatively smaller change in another variable, the relationship is inelastic. The coefficient of elasticity is less than 1
• Unitary elasticity


  Represents a situation where consumers or producers are equally responsive to changes in price. The coefficient of elasticity is equal to 1
• Measurement & Meaning


  1. Arc ELASTICITY

  2. Ep = (Q2 - Q1) / (Q1) / (P2 - P1) / (P1)

  3. Where: Ep= Elasticity Coefficient, Q= Quantity Demanded, P= Price, = Original Quantity Demanded, = New Quantity Demanded, = Original Price of the Good, = New Price of the Good
• Example Problem 1


  • Em usually buys 2 pack of laundry detergent with a price of Php 30. When the price decreases at Php 25, Em can now afford to buy 5 packs
• Example Problem 1


  1. Given: = 30, = 2, =25, = 5

  2. Solution: %Q = (5 - 2) / 2 x100 = 85.71%, %P = (25 - 30) / 30 x100 = -18.18%, Ep = |-4.71| = 4.71
• Types of elasticity of demand

  • Price Elasticity of Demand > 1 (Elastic)
  • Price Elasticity of Demand <1 (Inelastic)
  • Price Elasticity of Demand = 1 (Unitary Elastic)
  • Price Elasticity of Demand = 0 (Perfectly Inelastic)
  • Price Elasticity of Demand = ∞ (Perfectly Elastic)
• Example problem 1


  • Mark usually plays at a computer shop for 5 hours with the price of Php 10 pesos. Due to increase in electric bill the payment for hour rises to Php 25, so he only got to play for 2 hours only
• Example problem 1


  1. Given: = 10, = 5, =25, = 2

  2. Solution: %Q = (2 - 5) / 5 x100 = -85.71%, %P = (25 - 10) / 10 x100 = 85.71%, Ep = |-1| = 1 (Unitary Elastic)
• Point elasticity


  Measures the degree of elasticity on a single point on the demand curve. Changes on a single point are infinitesimally small. This type of advanced measurement is used in quantitative research and decision-making
• PRICE ELASTICITY OF DEMAND DETERMINANTS

  • Availability of Substitutes
  • Necessity of the Product
  • Number of Competitors
  • Adjustment time
  • Income Proportion
• Availability of Substitutes


  The share of each substitute product in the total demand begins to decline as the substitute product rises. Every substitute's individual demand is more elastic. consumers can choose to purchase the substitute instead of the industry's product
• Necessity of the Product


  The relative necessity of a product depends on its place in the hierarchy of needs, with essential products being the most essential and nonessential being the least essential
• Number of Competitors


  When new entrants compete with a seller who used to dominate and control a market, individual demand could be elastic and even perfectly elastic when products are homogenous
• Adjustment time


  In the long run, buyers can continually adjust to price changes. With the discovery of new energy sources over the years, global demand has become less price inelastic and may even be elastic
• Income Proportion


  The price elasticity of demand of a product also depends on how much one spends on it relative to his/her total budget and, therefore, how much one feels it as a cost
• PRICE ELASTICITY OF DEMAND and pricing

  The ratio of the percentage change in quantity demanded of a product to the percentage change in price. Economists employ it to understand how supply and demand change when a product's price changes
• Revenue (sales)


  Simply the price (P) times quantity demanded of the product. R=PQ
• What happens to revenue under the following conditions?

  • Price Increases, Elastic: Revenue decreases
  • Price Increases, Inelastic: Revenue Increases
  • Price Decreases, Elastic: Revenue Increases
  • Price Decreases, Inelastic: Revenue Decreases
• Cross-price elasticity of demand

  Measures how quantity demanded changes as the price of related good changes. A+ (positive) sign signifies that the two goods are substitute goods, a - (negative) sign indicates that the two goods are complements
• Income elasticity of demand


  Ep is the coefficient, %D is the percentage change in total demand, %Y is the percentage change in income
• Revenue


  Sales = Price (P) x Quantity demanded (Q)
• What happens to revenue under different conditions

  • Price Increases
  • Price Decreases
• Elasticity


  • Elastic
  • Inelastic
• Elastic price


  Revenue decreases
• Elastic price


  Revenue increases
• Inelastic price


  Revenue increases
• Inelastic price


  Revenue decreases
• Cross-price elasticity of demand


  Measures how quantity demanded changes as the price of related good changes
• Positive cross-price elasticity


  Substitute goods - as price of substitute increases, demand for other good increases
• Negative cross-price elasticity


  Complement goods - demand for a good increases when price of complement decreases
• Income elasticity of demand

  Coefficient Ep = %D/%Y, where D is percentage change in total demand and Y is percentage change in average/per capita consumer income
• Normal/Superior goods


  • Demand increases when buyer's income increases
• Inferior goods


  • Bought when buyers cannot afford more expensive goods, so they buy inexpensive ones they can afford
• Solving for income elasticity in Situation 1

  1. Given: D1=2 kilos, D2=3 kilos, Y1=10,000, Y2=14,000

  2. %D = (D2-D1)/D1 = 0.67

  3. %Y = (Y2-Y1)/Y1 = 0.33

  4. Ep = %D/%Y = 2.03
• Solving for income elasticity in Situation 2

  1. Given: D1=10 packs, D2=8 packs, Y1=10,000, Y2=14,000

  2. %D = (D2-D1)/D1 = -0.22

  3. %Y = (Y2-Y1)/Y1 = 0.33

  4. Ep = %D/%Y = -0.67
• Price elasticity of supply


  Measures how responsive quantity supplied is to a change in price, computed as Ep=%∆Q/%∆P
• Types of price elasticity of supply

  • Elastic
  • Perfectly elastic
  • Inelastic
  • Perfectly inelastic
• Elastic supply


  • Supply is price elastic or sensitive to price, shown as a shallow/low-sloping supply curve